CTS Corp (CTS) Q4 2018 Earnings Conference Call Transcript

CTS earnings call for the period ending December 31, 2018.

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CTS Corp  (NYSE:CTS)
Q4 2018 Earnings Conference Call
Feb. 05, 2019, 11:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day and welcome to the CTS Corporation Fourth Quarter and Full Year 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kieran O'Sullivan. Please go ahead, sir.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Thank you. Good morning and thank you for joining us today, and welcome to CTS' Fourth Quarter and Full Year 2018 Conference Call. Sales in the fourth quarter were $120 million, up 8.3% versus the same period in 2017. We added three new customers in the quarter. Fourth quarter adjusted gross margins were 35.5%. Fourth quarter adjusted earnings per share of $0.41 were up from $0.39 in the fourth quarter of 2017.

Full year sales were $470.5 million, up 11.2% from $423 million in the prior year. We ended the year with total booked business of $1.87 billion, up $129 million from 2017. Full year adjusted gross margins were 35.1% compared to 34.3% in 2017. Full year adjusted earnings per share of $1.53 were up from $1.23 last year, a 24% improvement. We have now gone live at seven locations with our ERP rollout.

Ashish Agrawal is with me for today's call and will take us through the Safe Harbor statement. Ashish?

Ashish Agrawal -- Vice President and Chief Financial Officer

I would like to remind our listeners that this conference call contains forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements.

Additional information regarding these risks and uncertainties is contained in the press release issued today and more information can be found in the Company's SEC filings. To the extent that today's discussion refers to any non-GAAP measures under Regulation G, the required explanations and reconciliations are available in the Investor section of the CTS website.

I will now turn the discussion back over to our CEO, Kieran O'Sullivan.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Thank you, Ashish. In 2018, we exceeded our targeted sales growth of 10% with the result of 11.2%, a solid achievement by our CTS team. We ended the year with an organic growth rate of 10.8%. Total booked business at year-end was $1.87 billion, up 7.4% from $1.74 billion at the end of 2017.

In the fourth quarter, we added three new customers. And for the full year, we added more than 10 new customers in several end markets. These results reflected the solid execution of our strategy and our operational effectiveness.

We remain focused on being a leading supplier of sensing and motion devices and connectivity components, enabling an intelligent and seamless world. We recognize that we need to maintain our focus in a more uncertain economic environment. We are confident that the careful transition of our technology, competitive global footprint and customer relationships, supported by our talented associates, positions us for growth in our end markets.

We continue to expand our product portfolio and our geographic reach with increased sales in Europe now at 15% of revenues. We have more to do as we transition our Company for success beyond 2020. Growth will be driven by demand for sensing, connectivity, precise motion, reduced size, electrification and automation, advancing safety and improving our environment as our world becomes more connected.

We are making solid progress. In the fourth quarter, we secured several notable wins. We secured precision frequency application, travel position and sensing module wins with future annual revenues of $2.5 million; the EMC product continues to gain share in the marketplace where we win with our multi-layer technology; and we added the new telecom customer.

In medical imaging applications, we secured a two-year contract with a large customer. Defense wins were driven primarily by sonar applications and next-generation torpedo component wins with future annual revenues of $2.5 million. We continue to gain traction with our expanding RF filter portfolio and see interest and demand for prototypes for applications, driven by our universal design and ClearPlex platform.

In transportation, we secured two accelerator pedal wins and a large sensor win for passive safety applications totaling more than $75 million over the program lifetime. Organic growth will be driven by regional expansion with our customers and enhancing our technology and product portfolio. We continue to increase our investment in innovation by working closely with our customers to ensure success. We are increasing our investments in RF filters to support the increasing interest in the product line and next-generation 5G requirements.

Our teams are also focused on expanding our actuator competence to new applications. In medical markets, we continue to grow into new applications; while in industrial and consumer markets, we are focused on secure identification technologies.

We continue to target a combined growth rate of 10%; 5% organic and 5% through strategic acquisitions. Making further progress in our end-market profile is a strategic priority for us. While we've made some progress in medical and defense, we have a lot more to do.

We will stay the course in our strategy as we strengthen our M&A pipeline and continuously review rationalization opportunities in our portfolio. We remain focused on adding the right technologies, expanding our geographic reach and strengthening our product portfolio and customer relationships.

In January, we transferred the last production line from Indiana for our transportation products, bringing our best cost footprint to more than our targeted goal of 80%. The transfer of the single crystal technology to Lisle is slightly behind schedule, but we expect to conclude this transfer in the weeks ahead.

Additionally, our ceramic product team has successfully advanced the qualification of back-end finishing in Tianjin this past year. Our SAP rollout will continue in 2019 and will position us to gain further efficiencies beyond 2020.

We continue to monitor the impact of tariffs and the current rate negotiations. Commodity cost was a headwind for us in 2018. We are expecting another $1 million to $2 million of impact in 2019. The recent minimum wage increases in Mexico, which came into effect January 1st of this year will impact us by approximately $1 million to $1.5 million.

As always, we are driving productivity programs and improvements through our supply chain to help offset these impacts. End markets look more challenging in the year ahead, driven by global trade challenges and slower China growth. Uncertainty persists in the transportation market as we are at the later stages of the cycle and expect flat-to-single digit declines in the year ahead.

From a European perspective, we have low exposure to diesel. In Asia, we have little exposure to Chinese domestic OEMs which have seen the largest decline versus the transplant OEMs where we have a strong position. We saw lower bookings in industrial and distribution in the fourth quarter and expect softness in the first half of the year. Medical and defense end markets remain robust where we continue to see solid growth.

In 2019, profitable growth, margin improvement and end market profile will be priorities for us. For full year 2019, we expect sales to be in the range of $460 million to $500 million and adjusted earnings are expected to be in the range of $1.50 to $1.70.

At this time, Ashish will walk us through the financial performance in more detail. Ashish?

Ashish Agrawal -- Vice President and Chief Financial Officer

Thank you, Kieran. Fourth quarter sales were $120.1 million, up 8.3% versus the prior year. Foreign currency rates impacted sales unfavorably by $900,000. Sales to transportation customers increased by 7.2% and sales to other end markets increased by 10.2%. Our gross margin was 35.5% for the fourth quarter compared to 34% in the fourth quarter of 2017, which was adjusted for pension settlement charges. During fourth quarter 2018, we realized approximately $1.5 million in savings related to product line transfers.

Our effective income tax rate in the fourth quarter of 2018 was minus 4.1% due to certain discrete items. As we completed our 2017 tax return, we elected to make certain tax accounting method changes related to tax planning strategies around the 2017 Tax Act. These changes resulted in a significant favorable impact on our 2017 tax return and caused our GAAP tax rate to be very low during the fourth quarter of 2018.

Our fourth quarter 2018 earnings were $0.52 per diluted share. Excluding restructuring, currency, tax and other one-time items, adjusted earnings per diluted share were $0.41, up $0.02 compared to the fourth quarter of last year.

For full year 2018, sales were $470.5 million, up 11.2% versus the prior year. Foreign currency rates impacted sales favorably by $3.2 million. Sales to transportation customers increased by 9% and sales to other end markets increased by 15.3%.

Our gross margin was 35.1% for the year, an improvement of 80 basis points from last year's gross margin of 34.3% which was adjusted for the pension charge mentioned earlier. During 2018, we realized approximately $4.1 million in savings related to product line transfers.

Our effective income tax rate was 19.9% for the year. The key driver of the lower rate was the fourth quarter favorability, I mentioned earlier. This was partially offset by the tax charge we took earlier in the year in Taiwan to utilize certain expiring tax credits.

We expect our 2019 tax rate to be in the range of 23% to 25%, excluding discrete items. Our work on tax rate improvement projects is continuing. However, the timing of these shifted into late 2019. 2018 earnings were $1.39 per diluted share. Excluding restructuring, currency and other one-time items, adjusted earnings per diluted share were $1.53, a 24% increase from $1.23 in 2017.

Now I'll discuss the balance sheet and cash flow. Our controllable working capital, as a percentage of sales, was 14.8% in the fourth quarter. This higher number is a result of the safety stock that we built up to protect our customers, as we complete our product line transfers.

Inventory levels are expected to decline in the first half of 2019. We had another quarter of strong cash flow generation with $15.6 million in operating cash flows.

For the full year, we generated $58.2 million in operating cash flow. CapEx was $7.7 million in the fourth quarter and $28.5 million for the full year. CapEx for 2018 came in at the low end of our expected range as the timing of certain project completions shifted into 2019. We expect our 2019 CapEx to be in the range of 6% to 8% of sales and expect to return to more normal levels in 2020.

Cash and cash equivalents were $100.9 million on December 31, 2018 compared to $113.6 million at the end of 2017. Our long-term debt balance was $50 million at December 31, 2018, down from $76.3 million at December 31, 2017. Our debt-to-capitalization ratio was at 11.7% compared to 18.2% at the end of 2017.

We are live on SAP at five manufacturing and two shared-service locations. This is a significant effort for our teams and a lot of work has been done to make sure that we minimize the impact on our customers' operations. Our goal is to complete the roll out to our remaining locations in the balance of this year. During the fourth quarter, we repurchased 342,000 shares of our stock for $9.4 million.

This concludes our prepared comments. We would like to open the line for questions at this time.


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Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from John Franzreb of Sidoti & Company.

John Franzreb -- Sidoti & Company -- Analyst

Good morning, guys. Good quarter.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Thank you, John.

Ashish Agrawal -- Vice President and Chief Financial Officer

Hi, John, good morning.

John Franzreb -- Sidoti & Company -- Analyst

I actually want to start with the guidance. At the midpoint, you're kind of suggesting 2% topline growth, but you've cautioned in the press release that you are modestly concerned, in my words about limitation (ph) industrial end markets. At the midpoint, that would suggest that new program wins, we're going to have to backfill on the topline. Could you talk a little bit about that and your expectations in new program wins going forward in a tougher end market for some of your -- your key customers?

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Yes, John, just to give you some perspective, we talked about some softness in bookings in distribution and industrial coming out of the fourth quarter and we're cautious on transportation, but we're still continuing to grow and add new products to the line. And I would say, just for the comments this morning, our growth in defense and in medical areas is robust, and our innovation pipeline there is very strong.

So we feel good about that. So again, we've got a number of things we're working on having the pipeline. And we're kind of tempering that with just the whole global trade, what we're seeing with just some uncertainty out there and we're following our strategy and we're going to execute like we always have.

John Franzreb -- Sidoti & Company -- Analyst

Okay. So defense and medical wins are going to help offset. In a flat environment, on automotive, would you expect program wins that you've won in the past couple of years, plus content growth to result in positive revenue gain in '19 versus '18?

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Yes, I think the way we've always talked about it John is, with the recent wins that we have over the last number of years, now it comes to the auto cycle, even in a flattish market, we will do well. And then we'll complement that with our other end-markets as well.

John Franzreb -- Sidoti & Company -- Analyst

Perfect, got it.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

And maybe just to give you one other piece of color on it, when you look at the China, we are -- we're seeing softness as well. We've seen a bigger drop in sales in the domestic Chinese OEMs versus the transplants where we're stronger. And we don't have a heavy exposure at all to diesel in Europe where there's been a lot of term up.

John Franzreb -- Sidoti & Company -- Analyst

Right. And maybe this would be good times to refresh everybody. My understanding is most of your transportation business is North American. Can you kind of put brackets around where transportation is geographically?

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

If you look at the overall Company, it's how we talked about it. We see just over 50% of our revenue in North America, 15% Europe, and the balance in Asia.

John Franzreb -- Sidoti & Company -- Analyst

Okay, switching -- go ahead, I'm sorry Kieran.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

No, we're fine. Thanks.

John Franzreb -- Sidoti & Company -- Analyst

Okay, switching to the restructuring actions you're taking. You said you realized -- Ashish actually said realized $4.1 million in savings in calendar 2018. Sounds like some of the programs are being pushed back a bit as far as the timing of realizations and additional cost savings. What are your expectations in potential savings in 2019 and the timing of realizing those?

Ashish Agrawal -- Vice President and Chief Financial Officer

So John, the programs were actually completed mostly on schedule. There was some fine tuning to meet customer requirements and maintain a good supply chain. We expect another $2.5 million to $3.5 million of savings in 2019 and it will be less so in Q1 as we burn through the safety stock and we should see a further ramp-up after that.

John Franzreb -- Sidoti & Company -- Analyst

Got it. That was actually really my next question about the inventory and the impact on the gross margin. So you would expect sequential gross margin maybe to dip a little in Q1 versus Q4, is that a fair assessment Ashish?

Ashish Agrawal -- Vice President and Chief Financial Officer

We don't guide to the quarter gross margin, John, but I would expect gross margin to be slightly better in the out quarters than in Q1.

John Franzreb -- Sidoti & Company -- Analyst

Perfect, Ashish, thank you for that color, I'm going to get back in the queue.

Ashish Agrawal -- Vice President and Chief Financial Officer

Great, thank you.

Operator

Our next question comes from Hendi Susanto of G Research.

Hendi Susanto -- G Research -- Analyst

Good morning, Kieran and Ashish.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Hi, Hendi.

Ashish Agrawal -- Vice President and Chief Financial Officer

Hi, Hendi.

Hendi Susanto -- G Research -- Analyst

Kieran, can you share some insight and characterize what feasibility in inventories in channel for customers look like nowadays in particular in transportation and industrials? And when do you expect feasibility in rebuilding of inventories to take place despite of uncertainty. I know that it's hard to forecast that, but if you have some, let's say, like a data points or signpost that you are looking forward to?

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

I wish I could predict it accurately Hendi, but when you look at distribution, we saw some softness in the fourth quarter in bookings and also some inventories there, that will probably take some of the first quarter to burn off. In the automotive side of it and what we saw was more -- you know the North America side of it seems to be pretty, pretty decent on the on-hand days of supply.

China is not as clear, in terms of how it's doing. The retail sales were down a little bit, and then Europe is kind of bouncing along a little bit flat. And then on the industrial side, the only thing that really concerned us a little bit was just some products moving toward China, relative to some trade impacts and tariff impacts, I should say, on some sales there. They are the kind of things we've seen in the quarter and managing through.

Hendi Susanto -- G Research -- Analyst

Got it. And then, question for Ashish. So, you mentioned about share buyback in Q4, should we expect CTS to return to its -- share buyback expectations in 2019?

Ashish Agrawal -- Vice President and Chief Financial Officer

Hendi, our approach on cash has been pretty consistent throughout the years. We will look at the right thing to do. Our priority is more on M&A and we have used share buybacks opportunistically from time to time. So I'd leave it at that and as our first priority, we would want to stay focused on finding the right M&A opportunities for us. Kieran would you want...?

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

No, I just -- the only thing I'd add to that is something we always discuss at our Board meetings in terms of what's the right use of capital.

Hendi Susanto -- G Research -- Analyst

Okay. And then Kieran, do you have updates on the secure identification technologies? Like, how many customers are evaluating your products and what exactly the technology's competitive advantage?

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Yes, we're working with a few customers in this area, Hendi, using our PAs (ph) of ceramic technology. We can't talk about customers at this point in time because we're just in at different evaluation stages with them, but secure identification in mobile or in industrial applications is where we're working. We are encouraged by the progress we're making. And obviously, as we get further updates, we'd be happy to add more color as well.

Hendi Susanto -- G Research -- Analyst

Got it, OK. Let me return to the line. Thank you, Kieran Thank you, Ashish.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Thanks, Hendi.

Ashish Agrawal -- Vice President and Chief Financial Officer

Thank you.

Operator

Next we have a follow-up question from John Franzreb of Sidoti.

John Franzreb -- Sidoti & Company -- Analyst

Hey guys, you kind of just touched on a second ago about your capital allocation strategy and M&A. Could you kind of give us an update on acquisition opportunities, what are the most viable ones? Are they geographic or strategic? Can you just -- any kind of color would be helpful, Kieran.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Yes, John, what I would say is, echoing Ashish's point, that's a primary focus for us. And the other aspect of it is, we're doing a lot more work in our pipeline and getting healthier in the pipeline, still looking for that geographic expansion, the technology expansion and expansion with our customers are the criteria we're working toward, and quite frankly, we didn't make a lot of progress in that area and changing our end market profile in 2018. And as I mentioned in that and this is my stated remarks, profitable growth, margin expansion and end market profile are priorities for us in 2019. So we're going to work it.

John Franzreb -- Sidoti & Company -- Analyst

Okay, fair enough. And little bit on your expectations for R&D dollars and the spent there and where you'd like to be targeting internally, where do you think the most opportunity rests?

Ashish Agrawal -- Vice President and Chief Financial Officer

Yes, John we've talked about wanting to be in the 6% of sales range on R&D spend in the long run. We are slightly lower than in 2018 and I'm expecting an increase in 2019 as we work through various programs. But I expect us to remain at the less than 6% range for 2019 as well.

John Franzreb -- Sidoti & Company -- Analyst

I'm sorry, you say less than 6% range, Ashish?

Ashish Agrawal -- Vice President and Chief Financial Officer

Yes, under 6%.

John Franzreb -- Sidoti & Company -- Analyst

Okay. And what opportunities do you think are most attractive as far as spending your R&D dollars? I mean it sounded like RF filters before, so...

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Yes, RF filters to several things in the ceramics space that we're nurturing along and several in the transportation markets, a few in switch and control -- in the other side electronic components as well. And so we've got a number of things we feel good about, John.

John Franzreb -- Sidoti & Company -- Analyst

Okay guys, thanks for taking my follow ups. I appreciate it.

Operator

(Operator Instructions) At this time, we have no further questions in queue.

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Great. Well, thank you all for your participation on today's call. We look forward to giving you an update at the end of the first quarter. Thank you again.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.

Duration: 25 minutes

Call participants:

Kieran O'Sullivan -- Chairman, President and Chief Executive Officer

Ashish Agrawal -- Vice President and Chief Financial Officer

John Franzreb -- Sidoti & Company -- Analyst

Hendi Susanto -- G Research -- Analyst

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